Singapore Land Transport - Maybank Kim Eng Research 2015-10-12: Four issues for Minister Khaw

Singapore Land Transport - Maybank Kim Eng Research 2015-10-12: Four issues for Minister Khaw Singapore Land Transport COMFORTDELGRO CORPORATION LTD C52.SI  SMRT CORPORATION LTD S53.SI 

Singapore Land Transport - Four issues for Minister Khaw 

  • Completing bus transition should be positive. However, benefits are well-flagged. Unlikely to drive stocks. 
  • Potential negatives from rail-transition details, more stringent rail-maintenance requirements & evolving taxi market not fully appreciated. 
  • Maintain UNDERWEIGHT & SELL on ComfortDelGro and SMRT. 

Four issues for Minister Khaw 

  • Mr Khaw Boon Wan became Minister for Transport on 1 Oct, taking over from Mr Lui Tuck Yew. We think he will tackle four key issues during his term in office, with potential implications for SMRT and SBST, a 75% -owned subsidiary of ComfortDelGro. 

1) Completing bus transition. 

  • The government changed the bus -operating model in May 2014 (refer our report dtd 22 May 2014, Land Transport - Finally, the bus transition). This will be fully implemented from 2H16. Singapore’s bus industry will move to a tender system with the existing market sliced into 12 packages of routes. Three of the 12 packages will be put up for tender. One has already been awarded to privately -held Tower Transit (note). The remaining nine will be kept by incumbents SMRT and SBST on negotiated terms. The most important feature of the new regime is ownership of all operating assets by the government. Minister Khaw will need to complete this transition. 
  • Yet to be determined are: a) the profitability of the remaining nine packages retained by the incumbents; and b) the way the government will take control of the bus assets. 

Stock implications. 

  • We think Minister Khaw will be fair in his terms to the operators, to ensure the sustainability of the new model. We expect him to rely on contracted prices for the tendered packages to determine the profitability of the routes kept by the incumbents. He may also need to request for a budget to purchase all the bus assets currently held by the incumbents. 
  • We have factored in asset purchases of SGD1b in our forecasts for our two stocks: SGD200m for SMRT and SGD800m for ComfortDelGro. As the assets are likely to be transferred at book values, there should be no P&L impact. And while this could improve balance sheets, we believe it has been factored in by consensus and is unlikely to drive stock prices. 
  • On the contrary, any deviation from outright asset purchases may affect stock sentiment. 

2) Executing rail transition. 

  • A transition from the old operating model for all rail lines except Downtown Line (DTL) has been discussed for at least two years. DTL was awarded to SBST in Aug 2011. The tender was an improvement over previous ones as it shifts capex obligations to the government, which has full control over capacity expansion as and when needed. We believe a full transition is difficult due to operators’ obligations under the old regime (refer our report dtd 21 Mar 2014, Land Transport - Rail transition: Devil’s in the details) to purchase rail - operating assets from the government in the future. These form off - balance -sheet liabilities. We believe the government may take one step further from the DTL model to make the future business model even more sustainable. 
  • Under all existing rail arrangements, operators still bear fare -revenue risks. This makes it difficult to separate financial sustainability from the political sensitivity of fare changes every year. Hence, we believe the government may adopt a similar approach to bus and remove fare -revenue risks from the operators. This would be a positive development. 

Stock implications . 

  • We expect Minister Khaw to bring all rail lines under a single sustainable business model, which is asset -light and independent of fares. We reiterate our concern about the treatment of off -balance -sheet liabilities for the operators during the transition. It remains unclear if they would need to repay the cash owed to the government under the old regime. As SMRT does not have the balance -sheet strength to repay, we cannot rule out fund-raising. For now, we have assumed a status quo and not built any rail transition into our forecasts. 

3) Improving reliability of rail network. 

  • Poor rail reliability has a hot potato for some time. The LTA has identified maintenance lapses by SMRT as the root cause of a system-wide disruption on 7 Jul 2015. Apart from slapping a record fine of SGD5.4m, LTA has directed SMRT to review and improve its maintenance programme to prevent a repeat. 

Stock implications. 

  • We expect Minister Khaw to give top priority to rail reliability, which suggests there could be higher repair and maintenance spending by the operators. 

4) Addressing new taxi business models. 

  • Singapore’s taxi industry is evolving. The government will need to address changes wrought by newcomers such as Uber and GrabCar. The public is concerned about physical safety and a lack of regulatory oversight. Incumbent taxi operators are also griping about the unfair playing field. 

Stock implications. 

  • We expect Minister Khaw to impose regulations to ensure the safety of commuters when using the new operators. This could be in the form of mandatory training for drivers and maintenance standards for the vehicles used. However, we expect the government to allow these new entrants to continue their operations as they have helped to ease the shortfall in taxis during peak hours. This would spell competition for ComfortDelGro and SMRT. ComfortDelGro would be more affected, given its larger taxi operation.

What’s Our View 

  • We believe Mr Khaw’s decisions on these four issues will have a profound impact on the profitability of SMRT (SELL, TP SGD1.10) and ComfortDelGro (SELL, TP SGD2.70)
  • Of the four, we see one positive and three negatives. 

One positive. 

  • If the government completes bus transition with outright asset purchases from the operators, we expect better balance sheets and profitability. However, we believe this has been well-flagged and is unlikely to drive share prices. 

Three negatives. 

  • Instead, we caution that the Street may not have fully appreciated potential negatives from the other three. The first potential negative is, while a transition to a sustainable asset light model is positive, contractual obligations under the old regime are often overlooked. We cannot rule out the need to raise funds by SMRT, in order for it to repay its obligations under its old licence. 
  • The second is, we expect more pressure on rail profitability from a tightening of maintenance requirements. LTA’s recent call to SMRT to review its maintenance programme could herald higher expenses. 
  • Lastly, even though the government could impose more regulations on new taxi entrants, the latter are likely here to stay. 
  • We remain UNDERWEIGHT on the sector and reiterate our SELL ratings for ComfortDelGro and SMRT.

Derrick Heng CFA Maybank Kim Eng | http://www.maybank-ke.com.sg/ 2015-10-12
Maybank Kim Eng SGX Stock Analyst Report SELL Maintain SELL 2.70 Same 2.70
SELL Maintain SELL 1.10 Same 1.10